The utilities sector usually performs admirably when interest rates are low, but the Utilities Select Sector SPDR (XLU ) is up just 4.80% year-to-date, well behind the 17.67% returned by the S&P 500 Index as a whole, as of June 24.
Although XLU, the largest utilities ETF by assets, currently has a dividend yield of 3.12%, so far that yield hasn’t proven attractive enough to entice investors to take on the sector’s laggard status.
Good news may be on the way for investors considering XLU and other utilities ETFs, however.
Citigroup recent upgraded the utilities sector, one of the smaller sector allocations in the S&P 500, to “market perform” from “underperform” citing valuation and earnings opportunity.
“Taking the Utilities sector up from Underweight after more than 2,200 basis points of underperformance over the past year (and 1,150bps ytd) does not look that heroic, especially with an attractive valuation,” Citi Chief U.S. Equity Strategist Tobias Levkovich wrote in the recent report. “This group is one of the few not demonstrating peak-like earnings revisions and our lead-indicator model is helpful too.”
Examining XLU Opportunity Set
Although utilities are often classified as a defensive sector, it’s one that is very much levered to an economic reopening.
As the economy gets back to normal and more folks leave their houses, they’ll consume more power—particularly at higher-use commercial properties and venues.
Combine that with the sector’s reputation for reduced turbulence, and utilities offer investors a less volatile entry into the reopening trade.
Still, some market participants aren’t interested yet.
“Yet, the buy side has not liked the group for a good while based on our survey data going back a few years,” said Citi’s Levkovich. “Hence, we think of the group as under-owned, yet there are no clear catalysts for appreciation at the moment.”
Although utilities are historically inversely correlated to Treasury yields, Citi says there’s a chance a bond yield rise could actually help the sector this time around, because it would be a sign the economy is strudy.
“A rising bond yield could be supportive and our economic model also suggests some upside opportunity, but we doubt that investors will run to this group an economic acceleration since there are many cyclical stocks to buy instead,” according to Levkovich.
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